The Fed raising rates to over 5% wouldn't be surprising, former Treasury Secretary Larry Summers says
- The Fed may raise its policy rate as high as 5%, former Treasury Secretary Larry Summers said.
- Despite the volatility that could bring to stocks, the Fed risks making a policy error if doesn't go far enought to contain inflation.
With expectations for the Federal Reserve to deliver another 75 to 100 basis point rate hike this week, the central bank ultimately hiking its policy rate above 5% wouldn't be surprising, according to former Treasury Secretary Larry Summer.
Any hope that the Fed might pivot from its hawkish in the near term were dashed last week after the release of the August inflation report, which ramped up expectations for another 75 basis point rate hike and caused stocks to slide to their largest one-day decline since 2020.
"I think we are more likely to end up above 4.5% than below 4.5%, and it wouldn't surprise me if that rate has to get above 5% if we are really going to, in a determined way, contain and control inflation," Summers said.
But despite the volatility that could set off in the stock market, Summers pointed to the importance of the Fed staying firm on its inflation policy, lest officials risk making the same mistake Volcker did in the 1980s, when the former Fed Chair believed inflation had been tamed prematurely, causing an even steeper rate-hiking cycle than what would have been necessary.
But Summers isn't aware of an example where the central bank was too hawkish or too quickly on inflation, reiterating the need for the central bank to stick to its guns and raise rates "until the job is done," or until the Fed brings prices back down to its 2% target.
Economists think that will likely take a while, given that inflation is still flying sky-high at 8.3%. Billionaire investor Ray Dalio predicted that a policy rate of 4.5% would lead to a 20% decline in stocks, and Nouriel Roubini has warned the Fed could drive the US into a stagflationary debt crisis, causing stocks to plunge another 40%, Bloomberg reported.
"This is only about what the right path is for minimizing the total distress over a long time period ... Just as the doctor who delays your surgery or doesn't prescribe you a full course of antibiotics … does your health no favors, and ultimately causes you more suffering," Summers said. "So I think that lesson that in terms of minimizing the risk of a stagflationary catastrophe, the Fed has to be prepared to stay the course."
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